The defined benefit plan's role in a corporation is once again becoming increasingly important for U.K. companies, industry experts say.
Impacts range from exacerbating share price falls such as at Tesco PLC, whose stock price dropped late last month on speculation of an increased pension fund deficit, to stalling mergers and acquisitions and sometimes even contributing to the end of M&A talks.
And in some cases, a large pension fund deficit can be a benefit to a corporation if it makes it an unattractive takeover target, as was the case several years ago for BT Group PLC.
“The fact that pension plans have become such a large deal is an inevitable consequence of 50 years of defined benefit liability accrual, and at the end of that period we have (in some cases) substantial sums of money which will cast a shadow over the corporation that is responsible for it,” said Bob Collie, Seattle-based chief research strategist, Americas institutional, at Russell Investments.
Global supermarket giant Tesco, Cheshunt, England, on April 20 saw its share price fall 0.72% to 235 pence, with fluctuations throughout the day, amid speculation that the deficit on its £8.4 billion ($12.6 billion) pension fund had swelled to £5 billion. The deficit as of Feb. 28 was revealed as £3.9 billion two days later, along with a record annual corporate loss of £6.4 billion. On April 22, the share price fell 5.4% to 223 pence.
In an analyst presentation April 22, David Lewis, Tesco CEO, said the company had reached an agreement with pension fund trustees under which Tesco will make cash contributions of £270 million a year to the pension fund, to be reviewed every three years. The corporation is also in the midst of a consultation into the closure of the pension fund.
“Defined benefit obligations do impact on corporate life, but there is a balance to be struck,” said Tony Hobman, London-based chairman of the advisory board at pensions advisory business Lincoln Pensions Ltd., and former CEO of the U.K.'s The Pensions Regulator. “There may be competition for cash in a (corporation) — does it go into supporting a (pension) scheme, or should it be used for other areas of the business, like research and development? Under the new code (from The Pensions Regulator) and the regulator's statutory objective, scheme funding needs to be seen in the context of employers' sustainable growing plans.”
Pension funds are also a significant focus for equity analysts when valuing a firm. Peter Elwin, deputy head of European equity research at J.P. Morgan Chase & Co. in London, said: “The significance of a pension scheme to a company is best assessed by comparing the underlying liability with the company's market cap. If the pension liability is the same size as the market cap or more, then that's a potential concern.”
Mr. Elwin said he looks at the liability rather than the deficit, “because that is very volatile. You can have a plan with a surplus one day, and then none.” There is also no credit awarded to a corporation with a pension fund surplus.
Clive Black, head of research at Shore Capital Group Ltd. in Liverpool, England, added that pension responsibilities are one of the factors that “are materially considered” when making a valuation. “There is plenty of evidence where the pensions tail wags the dog. But over the past five to 10 years, there has been significant progress made by British corporations in managing their pensions responsibilities.”